Exchange-traded funds (ETFs) have evolved from a tactical trading tool into a core portfolio management instrument for institutional investors, with adoption continuing to accelerate across North America, according to S&P Global.
Once primarily used for short-term portfolio functions such as liquidity management, manager transitions and portfolio completion, ETFs are increasingly being deployed as long-term strategic investments as institutions shift towards passive investment strategies.
Research conducted by Crisil Coalition Greenwich on behalf of S&P Dow Jones Indices surveyed 150 institutions across the United States and Canada, finding that ETFs have become a mainstream component of institutional portfolios.
More than half of North American institutions now use ETFs, with 54% reporting exposure to the investment vehicle. Adoption is highest among U.S. institutions, where 56% use ETFs.
The largest institutions by assets under management are among the most active users, with more than half of funds managing between $1 billion and $10 billion using ETFs, while nearly two-thirds of institutions with more than $10 billion in assets have adopted them.
Insurance companies, endowments and foundations are among the strongest adopters, with more than 70% using ETFs in their portfolios. Corporate pension funds are also increasingly considering adoption, with 44% exploring ETF investments.
ETFs shift from tactical tool to strategic allocation
Institutional adoption of ETFs initially focused on flexibility and liquidity, allowing investors to quickly adjust portfolio exposures. However, growing acceptance of passive investing has transformed ETFs into a preferred vehicle for gaining long-term market exposure.
"ETFs’ liquidity and ability to rapidly access exposures" made them valuable for tactical portfolio functions before institutions began expanding their use across broader investment strategies, according to the S&P Global research.
Today, most institutional ETF holdings are passive investments designed to provide strategic exposure rather than short-term tactical positioning.
Nearly two-thirds of institutions, or 63%, use ETFs to obtain strategic long-term exposures, typically as part of passive allocations within core-satellite portfolio structures.
Almost 90% of institutional ETF users employ passive equity ETFs, while 54% use passive fixed-income ETFs.
This shift has coincided with the broader growth of index investing, with almost all institutions — 98% — indexing at least some portion of their portfolios.
Approximately one-third of North American institutions allocate at least 25% of their assets to indexed investments, with the proportion rising to around 40% among public pension funds and 50% among insurance companies.
Liquidity and low costs drive ETF adoption
Institutions cited liquidity as the leading reason for using ETFs across both equity and fixed-income portfolios.
Other key advantages include ease of use, rapid access to asset classes, lower management fees and reduced trading costs.
Rather than seeking alpha generation, institutions increasingly view ETFs as efficient tools for capturing market beta.
Despite widespread adoption, ETF allocations remain relatively modest. Only one-third of North American institutions allocate more than 10% of their portfolios to ETFs.
Smaller institutions tend to have larger allocations, with 46% of smaller investors allocating more than 10% of assets to ETFs. Meanwhile, nearly 90% of the largest institutions — those managing more than $10 billion — allocate less than 10%.
ETF industry expands beyond traditional indexes
The evolution of ETFs has continued beyond traditional benchmark products, with issuers increasingly launching active strategies, options-based products, derivatives-focused funds and international market exposures.
GTS Securities principal Reggie Browne noted on the New York Stock Exchange’s ETF Central podcast that the ETF industry has transformed from simple index-tracking products into a sophisticated investment ecosystem.
"We’ve gone from simple benchmark, cheap-beta products to extremely complex vehicles," Browne said.
Browne, who helped develop liquidity in the early ETF market and now oversees ETF market-making activities at GTS Securities, said the industry's growth has been driven by improving accessibility and efficiency.
"When investors buy an ETF, they’re generally buying it from a market maker," Browne said. "Our job is to provide continuous markets, price the underlying basket accurately, and make sure investors can trade efficiently."
The increasing complexity of ETF products means issuers must consider factors including underlying asset liquidity, foreign exchange costs, taxes, market access and replication methods.
"What is in the basket? How do we price it? How do we replicate it? And what is the true cost of ownership?" Browne said.
Future growth expected in active and private market ETFs
Institutional demand for ETFs is expected to continue rising, with more than one-third of institutions planning to increase allocations over the next three years.
More than 35% of institutions intend to increase their use of passive ETFs, while more than 20% expect to expand allocations to active ETFs.
Private markets are also emerging as a potential growth area, with ETFs being explored as a way to provide easier access to traditionally illiquid assets.
More than a quarter of institutions globally expressed interest in accessing private markets through ETFs, including one-third of Canadian institutions and 45% of insurance companies.
Browne believes ETF adoption still has significant room to grow, predicting the U.S. market could eventually add thousands more ETFs as mutual funds transition into ETF structures and investors seek increasingly specialised strategies.
"We have to separate investing tools from trading tools. Some of these products aren’t appropriate for every investor," Browne said.
With transparency, accessibility and lower costs remaining key advantages, institutional ETFs appear positioned to become an increasingly important part of global investment portfolios.
